US tax filing: Help for NRIs on how global income is taxed

It's tax filing season in the US. As we approach the last date, 17th April 2012, for filing tax returns for the year 2011, here's some help for NRIs living in the US on how their income from India gets taxed.

Tax on global income in the US

If you a US resident or US citizen (whether NRI, PIO or OCI), you must pay taxes in the US on your global income. Before we proceed, let us quickly look at the definition of US resident.

A person is said to be a resident of the US if he meets either of these two tests:

1) The first test is the 'green card test'. If at any time during the calendar year you were a lawful permanent resident of the United States according to the immigration laws, and this status has not been rescinded or administratively or judicially determined to have been abandoned, you are considered to have met the green card test.

2) The second test is the 'substantial presence test'. To meet the substantial presence test, you must have been physically present in the United States on at least 31 days during the current year, and 183 days during the 3 year period that includes the current year and the 2 years immediately before. To satisfy the 183 days requirement, count all of the days you were present in the current year, and one-third of the days you were present in the first year before the current year, and one-sixth of the days you were present in the second year before the current year.

If you are a green card holder (or a US citizen), you are considered a US resident for tax purposes irrespective of where you actually live. We will study the requirements of filing US tax returns for green card holders and US citizens living in India in another article.

If you are not a green card holder, then you must satisfy the substantial presence test. In this article we will see the US tax filing requirements for those who are actually living in the US.

How are various incomes taxed?

Having seen the definition of US resident, let us look at the various incomes in India and the tax implications on your US tax returns. While we are explaining the broad contours of the law, we strongly recommend that you read the relevant sections in the income tax act of both countries, the DTAA and also consult an expert for your specific case.

Salary

If you are a resident of the US but earned a part of your salary in India, then, as per the above definition, you would have to pay tax on your India income in the US. Is the payer in India subject to deduct tax at source in India? Not really. Article 16 of the DTAA states that salaries earned by a person who resides and works in country A (country A in this case being the US), shall be taxed 'only' in the country of residence, that is, the US. So if you are a resident in the US and are working in the US, you will pay tax on your India salary in the US.

However, it might happen that you earned salary in India before you became a resident of the US and tax was deducted at source on that income in India. In such cases, you can claim a credit of the taxes paid in India in the US.

Rajesh Vaidya, a chartered accountant from India who is currently a member of the American Institute of Certified Public Accountants and works at Florida based Raju Maniar CPA firm makes an important point, "I would like to highlight a grey area here. In India, various components of the salary package are taxed differently. For instance, reimbursements and certain allowances are tax-free. In the US however, there is no such distinction; any payment received from your employer is taxable. Now your form 16 reports only the taxable components of your salary. Ideally, when you file your income tax return in the US, you must disclose all the tax-free components of your Indian salary and pay tax in the US on those components too."

How to report: You must include your salary income from India in the tax return Form 1040. In case you are claiming tax credit, you must also fill up Form 1116. Remember that the US follows the calendar year for tax purposes while India follows the fiscal year. You must pro-rate your income according to the relevant years.

Note: There is an exception to Article 16 which states that in case the employment is exercised in the other country, that is, in India, tax will be deducted at source. But this exception would apply mainly to green card holders and US citizens. We will see this in the next article.

If you are a consultant working in the US but receiving income from an Indian company, you would have to pay tax on that income in the US. This is irrespective of whether you receive the income in a bank account in the US or in India.